Bloomberg recently reported that Private Equity (PE) deals have fallen 70% in the first 10 months of this year, confirming what many in the industry have known for quite some time: economic conditions have put a near halt on deal flow and will continue to do so for the foreseeable future. At The Deal’s M&A Outlook Conference that started yesterday in New York, Jonathan E. Colby, a managing director at the Carlyle Group, shared his view on deal-making heading into 2009:

“There’s really no incentive for us to do anything now. We just have to sit tight and hope some liquidity come into the market next year.”

We’re hunkering down. Returns are going to come down just because of how long we’re going to have to hold these companies. We won’t see any meaningful deal activity in the market until the second half of next year.”

Others in the industry, such as Martin Hintze, a Managing Director at Goldman Sachs, fear that the credit market crisis may cause an even longer dry spell:

“We won’t get signs of a pickup in activity until 2010 at the earliest, maybe even 2011.”

In addition to not being able to finance new deals, the worldwide drop in asset prices will reduce potential selling prices for PE portfolio companies. This makes it unlikely for PE firms to exit their investment by selling. With little buying or selling on the horizon, now is the time for PE firms to focus on driving savings and operational efficiency in their existing portfolios. Since the previous five years have all seen record global M&A volume, most PE firms are sitting on a large and often very diverse portfolio of companies. Identifying and achieving savings takes on even more importance given these conditions, as Colby states:

“Operating expertise is critical right now in order to get these companies through the current environment.”

Sourcing and procurement operations will play a major role for any successful PE firm. At Ariba LIVE in the spring, there was an excellent presentation on this subject from Shant Mardirossian, a Partner and the CFO of Kohlberg & Company LLC. Shant’s procurement organization drives synergies and cost savings across multiple companies in their portfolio through the use of services and technology AND combining purchasing power for indirect spend across multiple companies. PE firms that are successful will need to use similar strategies that address the following questions:

• Do we have the global market, supplier, and category knowledge to gain price advantage and maximize cost savings? If not, how do we develop this knowledge?
• How can we effectively leverage spend across our portfolio to generate savings? Once we’ve identified this spend, how do we execute on it?

The global recession will yield many challenges, but also opportunity for cost savings in areas such as commodities, labor, transportation, etc. PE firms will need to take the lead in both individual company and portfolio wide cost reduction, making smart sourcing/procurement strategies critical to coming out in healthy financial shape.

Leron Baum is a member of Ariba’s Spend Management Services group. Leron specializes in spend management initiatives for Private Equity firms.